Certainty effect: people overweight certain outcomes vs probable ones. We tend to be less sensitivity to changes in probability in the middle of the range than changes that move us from probability to certainty

Fourfold pattern of risk attitudes

Risk seeking in the positive domain(when the probability of payoff is quite low)

Risk aversion in the negative domain (when the probability of loss is quite low)

Lotto risk seeking, insurance risk avoidance

Key Aspects

1) People sometimes exhibit risk aversion and sometimes exhibit risk seeking, depending on the nature of the prospect

2) People's valuations of prospects depend on gains and losses relative to a reference point. This reference point is usually the status quo

3) People are averse to losses because losses loom larger than gains

we feel greater pain from a loss than we feel pleasure for an equal sized gain

What people actually do. Positive Theory

Prospect theory allows for changes in risk attitude.

People care about change in wealth rather than level

Decision makers choose reference point and whether an outcome is perceived as positive or negative will depend on the reference point selected.

Integration Vs Segregation

If you segregate, always go back to ref point. if you integrate then you move up or down value function

Break even effect: take more risk after a loss in order to try get back to even. Path dependent behaviour

House money effect: after winning a big profit from house, gamblers increase the stakes and the risk they take. Suggests reduced risk aversion after an initial gain (not seen in prospect theory)

Endowment effect: people often demand much more to give up an item than they would pay to acquire it